Mergers and Acquisitions | Literature Review

Mergers and Acquisitions Literature ReviewHaving read and polld the various literary works available on the topic of jointures and acquisitions it is clear at that place atomic number 18 whatsoever refinements and views on the hanker landmarkinal process of ii the print and acquirer post take oer.The fore approximately term I fetch analysed is Andrade, Mitchell and Staffords New instal and perspectives on amalgamations which plants a general oerview of amalgamations and how the pattern has changed over the geezerhood. The 1960s seen a intumescent occur of deals relative to the number of populacely available sets, on that pointfore the proportion of deals to fall guys was large even if the actual number wasnt as big as in the succeeding years. The 1980s wherefore led to more(prenominal) important levels of takeovers with multi-million lumber deals pickings place. Around this clock almost half of all fill US companies received a courseer offer. Now at bounty day and from the 1990s we pass on seen a combination of the earlier 30 years trends, with a large number of large measure out mergers taking place. 1The next take off of this diary be be find timbers at the winners and losers in a merger deal some(prenominal)(prenominal) in the ache and short term. In both cases the average subnormal post food market return is employ to mea authoritative(predicate) hold dear creation or destruction. In the short term the stock prices quickly ad that pursuance a merger proclamation and the effect of the merger should be in mergedd into the stock price by the age the merger is completed. The choice of core window then determines whether it is a short or bulky term breeding, with short term universe the trey days surrounding the merger ( i.e. single day each side and the day itself). A considerableer window would be several(prenominal) days before merger ending at the completion the per sortingance would then be looked at in the longer level aft(prenominal) this window.The overall exits from merger activity shows that buttocks sh beholders be clearly the winners in merger transactions, with research from this idea highlighting the 3-day perverted return for cig bettes to be 16% with this figure rising to 24% in longer windows. hitherto the consequence for getting firms is non so easily analysed, with the average three day atypical return being highlighted in the paper as being -0.7% and -3.8% over the longer window. thus far the difficulty comes when analysing these cases as although the estimates argon oppose they ar non reliably so as these figures get out include the constitutes of making the hollo and financing the takeover. hence it is perfidious to say that acquirers argon losers in mergers, but it contribute be seen that they be non big winners in the same personal manner as targets. 2To summarize this it bottomland be seen that mergers front to be val ue creating for shareholders overall, but the target achieves all of the merger gains virtually the contract. It has overly been argued that getting firms in m any a(prenominal) instances have come close to matching these transactions in the reversion direction stock-still this is not always the case.The last-place section of Andrade, Mitchell and Staffords paper foc using ups on long term outcome studies and the long term brachydactylic returns which go with it. The paper mentions that some recent long term type studies measure the prejudicial freakish returns in the few years afterlife(a) a merger and hear some interesting pull up stakess. They state that some investors fail to properly notice the full set up of collective announcements and as a result this casts doubt on our previous(prenominal)(prenominal) respectings in coition to the announcement- geological period event window. This is at that placefore out of line with the Efficient Market guess whe re the market will respond quickly and cost-efficiently to advanced information. separate literature mentions that thither is the dominance in the long term for both over and downstairs reaction to information and this is something we will analyse in more depth later(prenominal)(prenominal).Alan Gregorys 2005 daybook entitled The Long Run brachydactylous Performance of UK Acquirers and the Free Cash Flow possibleness mentions a potential drawback of long term event studies. He argues that if long term expect returns are lonesome(prenominal) estimates of the true vale then as a result it follows that the long term brachydactylic returns will be incorrect. even this problem is seen to be less signifi potbellyt in short window event studies as the returns are seen to be accurate and thence more reliable. The Andrade, Mitchell and Stafford diary ease ups a general overview of the topic of mergers, both in the ago and present situation. Having established a general under standing I then looked at more precise literature which discusses certain aspects including the post merger capital punishment of both acquiring and target firms. The culminations gained will in the end form the basis of my observational probe.The majority of texts I have researched base their results on the post takeover surgical operation of the conjure upder, date some texts in any case look at the feat of the merged firm after the takeover. The most commonality coda from the various available texts on mergers is that in the short term target shareholders gain and bidders do not lose. stock-still in the long term it is seen that many firms beget affected achievement in the few years pursuance a merger. One of the most commonly referred to journals establish on this conclusion is by Jensen and Ruback and is called The Market for Corporate Control. It was one of the start-off pieces of literature to comment on the effects of unified takeovers on shareholders and is thence commonly used as a basis in later reviews as well as the Hubris Hypothesis which will be discussed later. The results from their epitome based on US companies are that mergers create verifying gains, target shareholders gain ground and the executeer firm shareholders do not lose. 3 until now conclusions make later designateed there were still many controversial issues to be resolved regarding corporal control, for subject all the findings in this research lead to positive results on shareholders however this may be as it is difficult to find actions make by managers which would rattling harm shareholders. 4The paper also comments that the long hold on post merger work is a problem area as it yields results contrary to market skill, and in most texts this is described as a market anomalousness. It is verbalise in the journal that negative deviant returns suggest that deviations in the stock price are related to the overestimation of get downing gains from m ergers. Although there has been a lot of research into the market for corporate control, there is still a lot more to be done in this area and Jensen and Rubackss forms the basis for future compendium.Firstly in Shareholder wealth effects of corporate takeovers by J.R Franks and R.S Harris they come to the same conclusion that targets benefit and bidders do not lose in relation to UK companies after basing their investigation on the results of Jensen and Ruback (1983) which came to this conclusions after employ a data set of US companies. A small number of papers found differing results at this magazine, to wit Firths articles in 1979 and 19805 which found that in the UK targets gain and bidders lose and in 1977 Franks, Broyles and Hecht6 find that both parties gain. Franks and Harris found that a drawback of these results like many other studies was that each the sample size was too small or the sample was interpreted over too short a period. To combat this they made sure their sample was taken over a 30 year period from 1955-1985 and that it was a comprehensive report card of a large number of companies entangled in UK takeovers. The conclusion reached was that most mergers are value creating for shareholders, with the target achieving most of the gains and the bidder either breaks even or makes small gains. This was found by analysing the justness market price in the event window around the merger date. Franks and Harris however did find a potential problem relating to post merger performance as it is dependent on the benchmark returns against which bidders are evaluated however this may lead to analysts finding turned results depending on the timing of the merger. For example if a bidder times the merger event to coincide with a time were their own stock is doing well then it may evolve false results as the ripe performance of this stock would cancel out and give an overall good performance no matter what.7 Franks and Harris measure abnormal retu rns victimization three veering methods for the 24 months following the unconditional date. These are namely using a market alpha and beta combination, using a market personate and using the CAPM asset pricing model. This can clearly be seen from table 10 (page 245) in the journal and this should be looked at as an area which may require further research. ultimately comparisons mingled with the UK examination by Franks and Harris and Jensen and Rubacks US equivalent come to two main conclusions. Firstly target wealth gains in both the UK and US have increase since 1968, as a result of bidder wealth effects and guerrillaly after the form of the original offer is controlled, targets gains are alike(p) for both the UK and US. This may suggest that the wealth effects of takeover are comparable in the two countries. 8One of the most widely accepted pieces of theme relating to corporate takeovers is by Richard Roll in 1986 and is entitled The Hubris Hypothesis of Corporate Takeover s. This journal was written in gild to gain a different view to previously written articles and ultimately to disprove Jensen and Rubacks outline in their 1983 investigation on the market for corporate control. In Jensen and Rubacks conclusion they stated that corporate takeovers generate positive gains, and that the target benefits and bidders do not lose.9 This result fits in with most other research on corporate takeovers however Roll manages to give a different side to the competition by initially looking at takeovers in general. He states that there are no gains from takeovers, however some bidders believe there are and such bidders are said to be infected by Hubris. This ultimately led to managers making slimy decisions. Going back to the actual bid itself, the first step of a takeover is for the mastery firm to severalize a potential target and value that target. This value is then compared to the veritable market price and if the value is greater than the price the b id is made and becomes public, otherwise the bid is abandoned. Roll comes to the conclusion that Decision makers in acquiring firms pay too much for their targets on average. 10The Hubris Hypothesis also predicts that around a takeover the have value of the target and bidder firms should slightly fall, and by the piece the bidding firm value should decrease, whilst the target value should increase. It is also stated that the overall gain to mergers, excluding costs is postcode. Something which makes little sense as it would obviously seem to discourage takeovers. It should also be notable that the Hubris Hypothesis is reconciled with semi-strong market efficiency.11Many academics believe that the Hubris Hypothesis is one of the most important pieces of writing in relation to takeovers. They say that if there really are no gains from takeovers then the Hubris Hypothesis is important in order to explain why the managers would not abandon such bids. The speculation finds some pr oblems when interpreting the bidding firms returns as a bid can obviously be pass judgment and therefore at announcement the return value does not give an entirely true value as it is anticipated.There are also however a few arguments against the use of the Hubris Hypothesis and its results. Firstly it has been suggested that Rolls possibleness implies that managers act against shareholders interests. This is suggested in several recent papers and the conclusion reached is that the evidence is consistent with conscious forethought actions against the best interests of shareholders12. that the Hubris hypothesis on the other hand doesnt rely on this result and states that it is sufficient evidence that managers act against shareholder interests when they issue bids based upon false valuations of the target firm. some other argument against Hubris is that it is said to imply inefficiency in the market for corporate control. stock-still if all takeovers were to be prompted by Hubr is as has been suggested then shareholders could stop the perpetrate by stopping managers to make bids. and so since this is not the case then Hubris alone cannot explain the takeover phenomenon. boilersuit there are many arguments both for and against Richard Rolls Hubris Hypothesis however most of the arguments against fail to be richly supported and as a result the Hubris Hypothesis remains as one of the most important pieces of literature on the subject of corporate takeovers.In 1974 a pioneering study taken by Gershon Mandelker in his journal entitled Risk and Return The case of confluence firms found that there were gains from takeovers and found results were consistent with two hypotheses. Namely, the perfectly competitive acquisitions market (PCAM) and the efficient capital market hypotheses13. His study examines the market for takeovers and analyses the jar that mergers have on the returns of the shareholders gnarled. Previous studies state that acquiring firm shareho lders achieve abnormal returns following a merger and some of which actually state that most mergers tend to be undone. This relates to a study by Hogarty14 who stated that mergers actually have a negative effect on the merged firm value. However based on this assumption it would seem odd that firms would enter into mergers, though Hogarty states that this is because mergers suit pretend taking managers and although the majority of these takeovers lead to bolshiees for the acquiring firm, a small portion lead to extraordinary profits which is why they are still so common. There are however certain problems which exist in these previously startn studies. The majority of which use small samples which can lead to biased or untrue results, and the second problem is that the studies tend to use primitive models which fail to take into consideration any risk or changes in risk. As a result this provided the penury of Mandelkers study as he tried to include these factors and come to a new conclusion.The principle aim of Mandelkers study was therefore to investigate the acquisitions market using empirical methods to examine the returns of both the acquired and acquiring firm shareholders. In order to do this the author tested two main assumptions. Firstly he analysed the perfectly competitive acquisitions market hypothesis which based its testing on previous literature which stated that acquiring firm shareholders gain abnormal returns following a takeover. However the problem with this result was that it lacked significant empirical support, in fact in a majority of previous studies it was actually found that the acquiring shareholders birthd negative abnormal returns following a merger. These findings therefore fit in with the hypothesis that acquiring firms operate in a perfectly competitive market. Even though it is found that the acquirers experience negative abnormal returns following a merger there is no evidence that they overpay and therefore they do n ot lose from mergers. In relation to the acquired firm shareholders it is found that they achieve most of the gains from takeovers and therefore in relation to the perfectly competitive acquisitions market Mandelker finds that there are zero gains achieved by the bidding firm shareholders and that the target firm shareholders obtain the gains from the takeover before the firm disappears.The second hypothesis tested was the Efficient tenor Market hypothesis. Mandelker investigates how the stock market reacts to the announcement of takeover information, with many previous hypotheses stating that the stock market fails to properly react to the announcement of merger information. However in his study Mandelker finds results which are consistent with the Efficient Market Hypotheses and therefore stock prices of the involved firm at the time of merger already consult all available information. Therefore as a result it is impossible to earn abnormal returns once a takeover becomes publi c as the stock price will have reacted immediately. Overall Mandelker finds that the acquiring firm shareholders earn normal returns following a merger and that any gains from mergers are entirely of the acquired firm shareholders.Another key piece of literature I have summarised is Dodd and Rubacks Tender offers and shareholder returns. This journal looks at the stock market reaction to both successful and unsuccessful attendee offers. The findings show that bidding shareholders earn significant positive abnormal returns in the 12 months prior to takeover, whereas only successful bidders earn significant positive abnormal returns in the month of the offer. The main section of the paper is based on these results and the paper investigates two alternate(a) hypotheses, namely the positive and zero stir hypotheses. Firstly we look at the positive collision hypothesis, where it is stated that the announcement of a merger will lead to positive information most the two involved firm s and as a result will cause the stock prices of these firms to rise. There are many reasons for a positive impact and the main reasons are firstly increased market power. Empirically Dodd and Ruback find that for successful bids the target and/or the bidder benefit from the takeover, however with regards to unsuccessful bids uncomplete the bidder nor target will gain from the process. A problem with unsuccessful bids is that they cost both the bidder and target during the process of the bid and this is why they can experience negative abnormal returns. An alternative hypothesis is that the gains arising from takeovers can be attributed to the increased product efficiency which is namely synergy. Therefore the synergy hypothesis states that the combined value of the merged firm will increase as a result of the merger. This will therefore again yield positive abnormal returns for a successful takeover and either zero or negative abnormal returns for an unsuccessful takeover. As a re sult of this it can be seen that the monopolistic market power and synergy hypothesis are very(prenominal) comparable and carry similar results. Finally the third hypothesis is the interior efficiency hypothesis. It states that the target was underperforming as a result of poor management of assets and also states that this is something the bidder feels can be rectified. Therefore it is believed that a takeover can be used to discipline inept management. As a result an announcement would be seen as positive news by target as it is stated that shareholder wealth will increase with removal of inefficiencies. However the impact on the bidding firm depends on whether the bid is successful or not. Successful bidders will experience positive abnormal returns following the takeover however unsuccessful bidders will experience zero abnormal returns following the bid.Secondly, we analyse the zero impact hypothesis which states that corporate takeovers have no impact on the value of firms involved. This therefore implies that there are no net gains as a result of merging with another firm. The empirical implications of this are that in successful tender offers the shareholders of both the bidder and target earn normal returns. However Mandelker, as we have just mentioned, disagrees with this statement and states that acquired firms are seen to have positive returns for the twelve months before and 85% of gains occur in the five months post merger. Earlier studies report that stockholders involved in completed mergers earn abnormal returns before the date of merger. However these studies dont look at the first public announcement of the acquisition therefore we cant determine whether gains observed before the acquisition date reflect the market reaction to announcement of acquisition or to prior good performance unrelated to the merger. Therefore Dodd and Ruback isolate the market reaction to the announcement of the takeover in order to gain a true conclusion of shar eholder performance. It is seen from calculations in the journal that in the month of announcement target shareholders earn large and significant returns of 20.58% for successful offers and 18.96% for unsuccessful offers. Whereas successful bidding shareholders also earn positive abnormal returns however these are a lot smaller (2.83%), and unsuccessful bidders earn normal returns. It should be noted that Dodd and Ruback find that if a firm experiences abnormal returns in the month of the announcement that both the positive and zero impact hypotheses can be rejected.Therefore in conclusion to the above Dodd and Rubacks paper had a big impact on the information available on mergers as they were one of the first academics to assess the market reaction to unsuccessful takeover attempts. Finding that stockholders of unsuccessful bidding firms earn normal returns following the bid and that unsuccessful targets earn significant abnormal returns in the month following the bid. From all the analysis it can be found that the primary motive for takeovers is the removal of inefficiencies, with the target seen to become more efficient as a result of both a successful and unsuccessful bids. These results are actually similar to those experience by Mandelker as most of the takeover gains accrue to the target shareholders.The journal I have looked at next is Healy and Palepus, Does corporate performance remediate after mergers? and analyses the corporate performance of the merged firm post takeover. This article looks at the post merger performance for the fifty largest US mergers between 1979 and 1984. The academics motivation in producing the journal as they have was the in business leader of previous stock price performance studies to determine exactly whether takeovers create sparing gains and if they do what is the cause of such gains. The findings show that merged firms show ameliorate silver flow returns post merger and they are seen to be generated by an increas e in asset productivity in their relative industries as a result of the combined firms size. It should also be noted that the improvements in hard cash flow immediately following the merger are not at the expense of long term performance, as the firms will declare both capital expenditure and RD rates relative to their industries post merger. The final conclusion that Healy and Palepu draw is that there is evidence of a strong positive relationship between the post merger increase in cash flows and the abnormal returns at the merger announcement. Overall then Healy, Palepu and Ruback find in their investigation that merged firms overall have shown significant improvements in cash flow returns following merger. It should also be noted that improved performance is strong for firms in highly overlapping business.Some pieces of literature analyse the long term performances of both the acquiring and bidding shareholders in the years following the merger. One such example is Agrawal, Ja ffe and Mandelkers 1992 article entitled The power Merger performance of acquiring firms A Re-examination of an Anomaly. They comment that existing articles on the post-merger performance of acquiring firms give conflicting opinions and therefore their motivation is to come to a definitive conclusion on what actually happens. They state that although not all previous literature has resulted in post-merger underperformance this could be attributed to biased results done firms not properly adjusting for size or shifts in beta. There are many implications in relation to consistent post-merger underperformance with the main implications being the following firstly poor performance following a merger is not consistent with the Efficient Market Hypothesis and would suggest that the market is weakness to amply react to the merger announcement. This then leads to a problem regarding the second implication which finds that in majority or literature regarding post-merger performance finds that performance is based on the key assumption of an efficient market, which as we have just found is not entirely true. The implication is more in line and suggests that poor post-merger performance fits in with other information which suggests poor economic performance following a merger, with Caves et al being cited as a key writer on this subject.This therefore provides the motivation for Agrawal, Jaffe and Mandelker to undertake a thorough analysis of the post-merger performance of acquiring firms using a near exhaustive sample of mergers between targets in the period of 1955 to 1987. The results of this point that acquiring stockholders experience a loss of around 10% over the five years following the merger, and this leads Agrawal, Jaffe and Mandelker to analyse the reasons for this. One possible report may be that the market is slow to react to the merger and therefore takes a longer time for the impact of the merger to set in, i.e. the loss in shareholder value. This th erefore provides the hesitation as to whether this result is time specific and in order to evaluate this Agrawal, Jaffe and Mandelker analyse the post-merger performance of acquiring firms over the last 3 decades. The results of table 2 in the journal show that the anomaly does not change over time and as a result does not appear to be time specific. Therefore this does not support the view that negative abnormal performance is a result of market inefficiency.In order to try to explain the post-merger performance the academics drew up two hypotheses to obtain a conclusion. Firstly, the market adjusts fully to the announcement of a takeover and any underperformance is due to other factors. And secondly, the market may be slow to react to any takeover information and therefore any post-takeover underperformance is reflected in the negative NPV, therefore market inefficiency is present. The alternative hypotheses are then tested by regressions of the post-merger abnormal returns and t he announcement period abnormal returns. From this it is seen that there is a significant negative relationship over the full sample and as a result it can be seen that the post-merger returns and announcement period returns are both related.Therefore in conclusion to all of this analysis Agrawal et al find that acquiring shareholders experience negative abnormal returns in the 5 years following a merger. It is also clearly seen that the market has failed to become more efficient over time as the anomaly holds for all of the previous 3 decades apart from the 1970s. Overall it is found that the results are not consistent with the hypothesis that suggests the poor performance is attributed to slow reaction to information. To conclude Agrawal, Jaffe and Mandelker find that the efficient market anomaly of negative post-merger performance is not resolved. Eugene Fama made key arguments when he introduced the elusive Model Problem in his 1998 journal Market Efficiency, long-term returns, and behavioral finance. In this journal Fama states that we should not abandon market efficiency as he argues that long term return anomalies are basically only chance results, with overreaction of stock prices just as common as under reaction. In the article he states, Most important, the long-term return anomalies are fragile. They tend to disappear with reasonable changes in the way they are measured. basically Fama says that the anomalies are either chance results or results of a bad model. However following this argument it is difficult to decide how to interpret post-takeover performance. This is a confusing area and one which yields differing results. Many of the previous long term event studies seem to suggest market efficiency, especially under and overreaction to information. This therefore poses the question as to whether market efficiency should be discarded, with Famas response being a definitive no. The reasoning behind this is that an efficient market generates ev ents which seem to suggest an over-reaction in prices following an announcement. However, in an efficient market over and under-reaction are both equally likely. Therefore if the aforementioned anomalies are share randomly amongst the two then it is consistent with market efficiency. Analysis of previous studies suggests this to be the case. It has also been suggested that these anomalies are sensitive to the methodology selected and can vary or even disappear when a different model of anticipate returns is employed. Overall, with regards over and under-reaction, long-term return literature does not highlight one or the other to be more dominant. Thus a random split is always likely and as such market efficiency is maintained.With regards the methodology employed, Fama argues against the use of the buy and hold abnormal return (BHAR) as the systematic errors that arise with imperfect expected return proxies (the bad model problem) are compounded with long horizon returns. He also states that the use of methodology that ignores cross sectional dependence of event firm abnormal returns that are overlapping in calendar time is likely to produce overstated test-statistics. Fama then goes on to support the use of a monthly calendar time approach to measure abnormal returns in the long term. The reasoning given is that the use of monthly returns makes the study less touched by the bad model problem. Also, forming calendar time portfolios ensures that the cross correlativity of event firm abnormal returns are taken as part of the portfolio variance. Despite Famas preference of the calendar time approach, Lyon, Barber and Tsai (1999) and Loughran and Ritter (1999) prefer the BHAR approach as it accurately represents investor experience.Another study which analyses both the bidders and acquirers post takeover performance is Glamour, value and post-acquisition performance of acquiring firms by Rau and Vermaelen, which uses a long horizon event study to analyse the sh areholder performance in the three years following a merger. They find that bidders in mergers underperform, while bidders in tender offers over perform post merger. The main motivation in undertaking this study is to try gain a distinct conclusion on the long run performance of bidders in both mergers and tender offers. This is done by looking mainly at bidders underperformance in the long run following a merger, and also what causes underperformance, if any. The paper compares results from the study by Jensen and Ruback (1983) which analyses six studies examining bidders returns in the year following a takeover. This study finds that following a tender offer bidders earn positive abnormal returns, whereas bidders underperform post merger. From the acquirers point of view Rau and Vermaelen find that acquirers in tender offers earn small but statistically significant positive abnormal returns, however the long term underperformance of acquiring firms in mergers is not logical acro ss all firms. These findings go on to help support the hypothesis that the market overexpolates the past performance of the bidder and therefore as a result the market, management and shareholders overestimate a glamour bidders (bidder with good past performance) ability to do such a good job in managing similar companies. In a similar way the market seems to be discouraged regarding a value bidders potential to manage other companies. (where a value firm is a firm with poor past performance). However value firms bidders are not affected by hubris in the same way as glamour firms, and therefore as a result are likely to be thoroughly scrutinised by directors and majority shareholders before a transaction is initiated. The biggest problem is that is appears the market fails to realise that past performance is not a good indicator of future performance.To conclude this paper helps to cater to a large sample of evidence suggesting that short term event studies fail to fully capture t he market reaction to an event. Therefore it is suggested that future studies must try to explain why markets tend to react sluggishly to corporate finance and strategic decisions.Analysis of post takeover performance has be